How Should Investors Handle Iraq?

Stunning Advance Brings New Risk For Investors

If top policy makers and military leaders were caught off guard by the military
action in Iraq, as reported by The
Wall Street Journal, then we can assume the same can be said for many investors.
From Reuters:

The stunning advance of the Islamic State of Iraq and the Levant, which
aims to build a Caliphate ruled on medieval Sunni Islamic principles across
Syria and Iraq, is the biggest threat to Iraq since U.S. troops withdrew
in 2011. Hundreds of thousands of people have fled their homes in fear
as the militants seized the main cities of the Tigris valley north of Baghdad
in a matter of days. The security forces of Iraq's autonomous Kurdish north,
known as the peshmerga, or those who confront death, took over bases in
Kirkuk vacated by the army, a spokesman said. "The whole of Kirkuk has
fallen into the hands of peshmerga," said peshmerga spokesman Jabbar Yawar. "No
Iraqi army remains in Kirkuk now."

Fear Can Be Tamed With Contingency Planning

Events that catch investors by surprise often induce fear and tossing and
turning at night. Making investment decisions based primarily on fear is a
recipe for stress, frustration, and disappointing performance in the markets.
A recent example was the scary 1929 parallel chart that was making the rounds
on Wall Street in the first quarter. Rather than liquidating stocks based on
the depressing 1929 head-and-shoulders analogy, we penned the following on February
11 as an alternative and more rational approach to portfolio risk management:

If we know the neckline has to break before the 1929 analogy can play
out, then we also know as long as the S&P 500 stays above 1,746 and
1,737, then the odds of a 1929-like crash are somewhat limited. Therefore,
one way to handle the 1929 scenario in 2014 is to:

Not lose too much sleep as long as the S&P 500 stays above the neckline
(1,746 and 1,737 are good reference points).

If the neckline is violated, begin to reduce risk in a pre-determined
manner using an IF, THEN strategy.

Did The 1929 Plan Help Reduce Stress?

The before and after charts say the simple and hypothetical "don't lose too
much sleep" strategy was useful from a psychological and investment perspective.

Back Of The Napkin Plan For Iraq

Our purpose here is to illustrate the concept of using guideposts to manage
stress and portfolio risk. A simple and hypothetical approach to the legitimate
concerns being raised about the unrest in Iraq is to use areas of possible
support on the S&P 500. For example, we might think along these lines:

If the S&P 500 closes below 1,902, consider making adjustments to
step three below.

If the S&P 500 closes below 1,880: (a) cut stock exposure by 10%,
and (b) choose the next prudent line in the sand to manage risk using an
IF, THEN strategy as outlined on October
18.

People Are Looking For An Excuse To Sell

The negative impact from Iraq was complimented by weak reports on U.S. employment
and retail sales. From Bloomberg:

"People are looking for a reason to sell stock right now," Dan McMahon,
director of institutional equity trading at Raymond James and Associates,
said in a phone interview. "The economic numbers were a little disappointing.
You can't make new highs everyday." Investors are watching developments
in Iraq, where Islamic militants extended gains after capturing the country's
second-biggest city, while the U.S. weighed an Iraqi request for air support.
Oil climbed to an eight-month high on concern the fighting will hurt exports
from the second-largest producer in OPEC."

Investment Implications - Prudent Decision Making

Since the market's pricing mechanism determines the value of our investments,
it is the market's reaction to Iraq, rather than our personal views or fears,
that is most relevant. If the situation in Iraq continues to escalate in a
troubling manner for stocks, it is unlikely that the S&P 500 will hold
above the 1,902 line in the sand. Conversely, if the S&P 500 remains above
1,902, then logic tells us the market is not overly concerned about the situation
in Iraq. The line in the sand gives us a firm guidepost to assist in our decision
making process.

We hypothesized Wednesday that
it would take a cluster of weak days to cause significant damage to the market's
tolerance for risk. As expected, Wednesday's session had little impact on the
readings of our market
model. Since the model serves as our guidepost for decision making, we
have made no allocation changes this week. We continue to hold stocks (VTI),
leading sectors (XLK), and Treasuries (TLT). If the incoming economic data
and unrest in Iraq result in further weakness in equities, we will not hesitate
to make the necessary defensive adjustments to our portfolios. For now, we
remain in "monitoring the situation" mode. If you prefer to build your IF,
THEN plan using the Dow as a guidepost, the chart below may be helpful.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable
but we cannot attest to its accuracy. Investment recommendations may change
and readers are urged to check with their investment counselors and tax advisors
before making any investment decisions. Opinions expressed in these reports
may change without prior notice. This memorandum is based on information available
to the public. No representation is made that it is accurate or complete. This
memorandum is not an offer to buy or sell or a solicitation of an offer to
buy or sell the securities mentioned. The investments discussed or recommended
in this report may be unsuitable for investors depending on their specific
investment objectives and financial position. Past performance is not necessarily
a guide to future performance. The price or value of the investments to which
this report relates, either directly or indirectly, may fall or rise against
the interest of investors. All prices and yields contained in this report are
subject to change without notice. This information is based on hypothetical
assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES,
EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM
ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money
management firm based in Atlanta, Georgia. CCM helps individual investors and
businesses, large & small; achieve improved investment results via research
and globally diversified investment portfolios. Since we are a fee-based firm,
our only objective is to help you protect and grow your assets. Our long-term,
theme-oriented, buy-and-hold approach allows for portfolio rebalancing from
time to time to adjust to new opportunities or changing market conditions.